I’ve mentioned many times that house flipping is getting a little “long in the tooth”. This week I was featured in BusinessWeek/Bloomberg on this topic ( great article here is the link in case you missed it). Nationwide flipping has grown exponentially. Unfortunately, many of these “flippers” are starting to face the hard reality of losing money. What is the key driver of these losses and why will this get even worse?
“Learn how to flip houses in 3 easy steps using someone else’s money” was a recent add I heard on the radio. Sounds like a great deal; everyone can make millions in real estate by “flipping a house” just by following three “secret steps”! Is this radio ad a reality? Can you easily strike it rich by flipping houses? Being a hard money real estate lender in Colorado, Georgia, and Florida and looking at hundreds of residential properties a year, I’d like to be the first to declare the “flip” is over in many parts of the country for the vast majority of investors.
What is a flip?
First let’s define what a fix and flip is. The objective of “house flipping” is to make money on the margin between what the house is purchased for + repairs and the net selling price (after holding costs, commissions, etc…). This is best understood through a quick example. Let’s say a house was acquired for 90,000 and 15000 was put in for repairs; the house is subsequently sold for 145,000 (less 5% commissions and hold costs) the net profit is $32,750 in 30 days. The net profit is approximately 62% annualized over a year. Quite a nice return! There is no wonder why it seems like everyone is now a “real estate investor”.
The above example is a best-case scenario where the property was bought at the right price, repairs were minimal, and the property was sold at the right price. As you can likely suspect, best case scenarios where all the stars align rarely happen. Unfortunately, real estate like any other industry is dictated by basic economics and the laws of supply and demand. This is what makes real estate not only exciting but extremely dangerous.
Why is the flip dead or dying?
- Prices too high
Prices in most markets has risen considerably. In many “hot” markets prices have increased by double digits year over year due to lack of supply and increased demand. At some point supply and demand eventually begin to come into balance for whatever reason. As they come into balance, prices typically will flatten/decline as demand recently has begun to slow.
A quick example of the outcome of too high of a price: On the same transaction above, instead of buying the property for 90k, now the property purchase price is 115k due to competition from not only other investors (seems like everyone is now trying to be a real estate investor on the side), but also homeowners that are looking for their first house. Under this scenario assuming everything else is constant, the total invested ( also known as basis) is now approximately 130,000 assuming the sales price is the same 145,000, the net profit is now only 7,750 after real estate commissions of 5%. This is a very small margin on a flip since inevitably something goes wrong (for example let’s assume you found out that the roof needs replacing or the furnace blows out setting you back another 6-8k).
- Market slowing:
House flipping is predicated on an investor being able to sell the property quickly. Most “flips” are bought using leverage meaning that the real estate investor is using leverage. Using leverage costs money in interest every day the loan is out. The longer it takes to sell a property, the less money a real estate investor makes as they are forced to continue making payments on their loan until the property sells.
As markets begin to slow, sales times will start to increase substantially at certain price points. For example, lets say a house due to the changing market conditions now takes 6 months to sell as opposed to 30 days. Using the same example above with a 115k purchase price and 15k in repairs bringing the initial basis to 130k. Let’s now assume 6 months of carry on 130k at 12%, this would add an additional expense of 7800 (excluding increases in costs for taxes, insurance, utilities, etc…) which brings the basis to 137,800 with a sale price of 145k and a 5% real estate commission, the profit is gone leaving a small loss of 500 dollars. The flipper likely lost more money once taxes, insurance, etc… are factored in.
- Sales prices falling:
In many markets, sales prices are starting to come off their highs with many sellers adjusting their prices to adjust to the new market realities. Take for example Seattle. Prices in some neighborhoods have declined about 4%. On the same scenario above the flipper would lose 6-8k, on paper that doesn’t seem so bad, but what if you were flipping a 500k home, this loss is now greater than 30k dollars.
All three of these factors above will likely worsen and lead to the demise of many flippers as the numbers no longer work and losses continue to pile up. Although the radio ad says: “you can flip a house in three easy steps using someone else’s money”; the reality of the situation is that most investors will barely break even, and many times lose money on a flip. As a result of the increased prices, slowing sales cycle, and market conditions worsening, the flip is officially dead for most real estate markets throughout the country
I need your help!
Don’t worry, I’m not asking you to wire money to your long-lost cousin that is going to give you a million dollars if you just send them your bank account! I do need your help though, please like and share our articles on linkedin, twitter, facebook, and other social media. I would greatly appreciate it.
Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).